Commercial Litigation: SEC Enforcement Trends

As public offerings have gotten more complex and expensive, capital has flowed to non-public securities. Consequently, the exempt securities market has expanded and increased in complexity and risk. Issued on July 27, 2017, SAS 133 is intended to provide guidance to bring auditing consistency across offerings and increase public confidence in the presentation of financial information.

Beginning with offerings made in June 2018, this new standard will apply when audited financials are used in connection with exempt securities offerings. Common exemptions involve private placements, municipal securities, not-for-profit securities, new crowd-funding and Regulation A offerings, and franchise offerings. Thus, heightened audit procedures will be the rule rather than the exception, applying in some form to both private and public capital raising efforts.

SAS 133 will apply when an auditor is “involved” in an exempt offering. Being involved has two components: (1) the auditor’s report is included or referenced in the exempt offering document and (2) the auditor performs specific activities with respect to the offering document like reading the offering materials, offering a comfort letter, or agreeing to allow the use of the report in connection with the offering. These requirements are designed to protect auditors from fallout from the use of their audits in connection with exempt offerings without their knowledge.
Among other things, SAS 133 will import the requirements AU-C Section 720 regarding “other information in documents containing audited financial statements” and AU-C Section 560, which requires auditors to consider whether events after the report would cause the auditor to revise the report.

This new auditing standard will require auditors to pay attention to two related developments. First, auditors will have to be more attuned to which transactions count as securities. For example, the SEC recently decided that offering cryptocurrency is a securities offering requiring registration or exemption. Second, auditors will have to consider how closely to hue to GAAP and the FASB’s auditing standards, which are not yet mandatory but do influence how disappointed investors seek redress for failed investments. For more information on non-GAAP accounting and the state of the industry, see our video here.

On May 31, 2017, Former SEC Chair, Mary Jo White and former SEC Director of Enforcement, Andrew Ceresney presented a retrospective on recent enforcement trends and their insights on where the SEC might be heading. Here are a few takeaways:

1. SEC enforcement actions are on the rise. From 2013 through 2016, 2,850 enforcement actions were filed. Judgments and orders over this period totaled more than $13.8 Billion. The use of big data contributed to the enforcement division’s increase in activity.

2. The number of enforcement actions involving accounting firms and auditors is also seeing an upward trend. From 2013 through 2014, the SEC brought 37 Rule 102(e) proceedings against accountants for improper professional conduct. That number rose to 76 proceedings from 2015 to 2016. The alleged improper conduct in these proceedings arose from claims of audit failure or independence violations. The SEC sees auditors as gatekeepers and partners in protecting investors and the integrity of the markets.

3. The SEC’s numbers show a steady increase in financial reporting cases since 2013. From 2013-2014, 53 financial reporting cases were filed and 128 parties were charged. From 2015-2016, those numbers increased to 114 financial reporting cases and 191 parties charged. Despite the increase in cases, the SEC hasn’t uncovered any massive fraud cases on the level of Enron and WorldCom. Ms. White and Mr. Ceresney attribute this to improved financial reporting and internal controls promoted by Sarbanes Oxley. The SEC would likely reconcile the touted effectiveness of Sarbanes Oxley with the increase in enforcement actions by arguing that regulations have deterred major crimes, allowing the Commission to focus on enforcing other violations.

4. We can expect to see some changes with the new leadership. The new chair, Jay Clayton, appears focused on capital formation. Consistent with the overall focus on reducing regulation, Chair Clayton has expressed a desire to reduce barriers to going public. This may lead to an increase in enforcement activity around initial public offerings.

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Carlock, Copeland & Stair has 15 lawyers in Georgia, Tennessee and South Carolina who spend most of their time representing attorneys and accountants. Our goal is to quickly and cost-effectively prevent or defeat claims against our clients. We understand the emotional and business pressures that malpractice claims present for busy professionals and pride ourselves on minimizing business disruption and client stress. We work hard to win every case and our success at trial and by motion helps to quickly resolve cases by agreement if that is the client’s desire.